South Korea dumps Libor for new benchmark

Will use Cost of Funds index

Aug. 22 (Bloomberg) -- South Korea chose a new benchmark rate for bank lending amid an antitrust agency investigation into borrowing-cost rigging that has drawn ire from customers and lawmakers.

The Financial Services Commission plans to use a so-called short-term Cost of Funds Index in cooperation with lenders as an alternative for banks to base their short-term lending rates on, the regulator said in an e-mailed statement today. The country’s banking industry group plans to publish the rate every Wednesday from November, it said.

South Korea is setting the new short-term lending standard after the Fair Trade Commission in July began probing banks and brokerages for possibly manipulating certificate-of-deposit rates. Global regulators are scrutinizing key rates, with Barclays Plc receiving a record fine for attempting to manipulate the London interbank offered rate.

“Lenders may benefit from shifting to short-term Cofix from the current CD rate as the new measure would better reflect banks’ borrowing costs,” said Hong Hun Pio, a Seoul-based analyst at KTB Investment & Securities Co. “Still, banks will have little room to expand their loan margin and spread amid criticisms following the antitrust agency’s probe.”

The new benchmark will draw from a group of lending instruments, rather than just the 91-day CD rate currently used. Short-term Cofix will be calculated by reflecting lenders’ average funding costs over three months based on repurchase agreements, the 91-day CD rate and time deposits. Details will be determined after further discussions, the regulator said.

Earnings Drop

While the short-term Cofix is expected to be 5 basis points to 10 basis points higher than the CD rate, it won’t raise borrowing costs as banks can adjust the spread, Koh Seung Beom, director-general of the FSC, told reporters today.

Combined earnings at 18 South Korean banks including KB Financial Group Inc. and Hana Financial Group Inc. plunged 59 percent in the quarter ended June 30 from a year earlier as loan margins narrowed and bad-loan provisions rose, the Financial Supervisory Service said July 30.

Net interest margin, a key measure of profitability from lending, declined to 2.13 percent last quarter from 2.32 percent a year earlier, the FSS figures showed.

Public Criticism

The FTC inspected 10 brokerages on July 17 and nine banks on July 18 to see if there was collusion in setting CD rates. The commission said at the time that it will closely review the inspection results, without identifying the firms. Lawmakers and civic groups criticized the nation’s banks and called for thorough investigations.

South Korea’s 91-day CD rate is set twice a day by the Korea Financial Investment Association based on an average from 10 brokerages. It’s the benchmark for almost 30 percent of won lending, and 421 trillion won ($371 billion) of interest-rate swap contracts were based on the rate as of March.

Given the balance of loans and derivatives tied to the rate, local lenders agreed to issue more CDs in order to publish a more sound figure, the commission said today. The regulator will bolster disclosure rules related to CD issuances and trading to improve transparency in the rate’s calculation, it said.

The CD rate has been losing its benchmark status as the balance of such products has shrunk to only 2.5 percent of banks’ total deposits, the FSC said on July 31.

The Cost of Funds Index was introduced in 2010 as a basis for longer-term household lending such as mortgages, according to the Korea Federation of Banks’ website. The federation announces the rate once a month based on quotes from a weighted average of nine banks. The current Cofix has an average maturity of around 10 months.

About 14 percent of banks’ local-currency lending was tied to the rate as of March, according to FSC data.

The new rate will be useful for short-term corporate loans and household credit, while the existing Cofix will remain valid for long-term debt such as mortgages, the commission said.